US CPI numbers show the downward path for inflation is likely to be bumpy

December’s CPI inflation report showed numbers slightly ahead of consensus in the US. On a month-on-month basis, headline CPI came at 0.3% compared to a Bloomberg consensus of 0.2%, whereas core CPI figures were in line with said consensus at 0.3%. These numbers leave the year-on-year numbers at 3.4% and 3.9%, respectively. Considering that November’s numbers were 3.1% and 4.0%, this means headline CPI increased while core CPI only fell marginally. Treasuries reacted accordingly, reversing the mini rally we had seen earlier in the day.

Looking into the detail, the numbers do not show any disastrous trend that makes us think the reversal in inflation numbers back to trend will not happen eventually. But we do see some signs that this journey might have a couple more stops than the market is anticipating. Services inflation remains sticky, a good part of which has to do with the ‘shelter’ component. This moves in a similar fashion to house price inflation, but with a significant lag. House prices were very strong post-Covid but the correction that many were expecting from the highs has disappointed. Shelter inflation accounts for 35% of headline CPI and just over 40% of core CPI and is currently running at 0.5% month-on-month, while the range pre-Covid was 0.2%-0.3%. The fact that house prices have been stronger than expected might mean that shelter inflation takes a bit longer to come down to pre-Covid levels.

From a macro point of view, it is not surprising to see monthly inflation numbers being volatile. The downward path in inflation is likely to continue to be bumpy and the “last mile” might prove more stubborn than declines seen in previous quarters. 

The Fed being reluctant to claim victory on the inflation front is also partly related to this point. What has been surprising though is the fact that, at least before this CPI print, a consensus was building for a first cut in March in the aftermath of Jerome Powell’s uber dovish press release after the Federal Open Market Committee (FOMC) meeting in December. We think a cut in March is unlikely. 

Although the selloff in short rates so far this year has resulted in the implied probability of a March cut receding somewhat, it does remain at close to 70%. We tend to think that this will reverse in coming weeks. Fed officials have tried to reverse the price action post December’s FOMC by pointing out that the battle is not won yet and this CPI print will give them more ammunition. It is likely that we see further chat from them about the loosening in financial conditions being a bit excessive.

In summary, December’s inflation print was not unusual, and the trend is still for inflation to come down to target eventually. But given that markets seem to have ignored that inflation will not fall in a straight line by pricing in a March cut this might mean that the short end of the curve reflects a lower probability of a cut in March in the coming weeks. The impact in the 10-year and 30-year might not be as pronounced in the context of inflation still moving in the right direction broadly speaking. But we wouldn’t be surprised if levels move a little bit higher and closer to pre-FOMC levels.